Almost Daily Grant's

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Tuesday, June 19, 2018

We'll make it up on volume

From Friday’s edition of the South China Morning Post:
 
A hotpot restaurant in southwest China went out of business in less than two weeks after customers took advantage of a promotion that allowed them to pay 120 yuan ($19) for all they could eat for an entire month.
 
“We knew we would be losing money [by launching the discount promotion],” one of the owners was quoted as saying. “We wanted to accumulate more loyal clients through this strategy.”
 
It’s all about location. Perhaps Silicon Valley needs a new dining option?

Dance of the living dead

Mixed signals abound in the U.S. corporate credit market.  While high-yield spreads remain near their tightest levels since 2007, investors have turned the cold shoulder to investment-grade in recent months: The ICE BAML U.S. Corporate Master Option Adjusted Spread has widened to 122 basis points, the largest pickup over Treasurys since April 2017.  Independent research firm Cantillon Consulting notes on Twitter that high yield’s premium to investment grade stands at its narrowest since early 2007. 
 
Particularly jarring is the action at the bottom rungs of these respective debt classes. Jason Goepfert, president of Sundial Capital Research, reports that the yield gap between triple-B-rated bonds and Treasurys has widened by 39 basis in the 90 trading days through June 11 while triple-C-rated spreads have sunk by 91 basis points during that period.  Goepfert summarized his findings to Barron’s: “What we’re seeing is highly unusual.”
 
So what gives? 
 
Supply differentials appear to be one factor. While investment-grade issuance has slowed, with Bloomberg tabulating $672.6 billion of new bonds coming to market this year through June 17, down 8.1% from a year ago, high-yield supply has been curtailed far more dramatically. Crowded out by increasingly popular floating-rate leveraged loans, the new supply of junk bonds has come to $109.4 billion through June 17 according to Bloomberg, that’s down 31% year-over-year. The drought in fresh high-yield supply isn’t expected to abate anytime soon. On June 15, analysts at J.P. Morgan slashed their 2018 new supply estimate to $265 billion from a prior forecast of $315 billion. 
 
The general backdrop could also explain investors’ preference for junk. Interest rates are slowly but surely departing from their near zero post-crisis perch. The effective Federal Funds rate currently sits at 1.9%, up from 0.38% in June 2016. The two-year yield has jumped to 2.55%, compared to 0.55% two years ago.  
 
Interest rates may be rising, but the bygone age of ZIRP continues to cast its shadow.  Risk appetite remains firm with stocks at or near their highs, and corporate deaths are few and far between.  Moody’s reports that the default rate for U.S. speculative-grade issuers fell to 3.7% in May, down from nearly 6% in 2016 and more than 14% in 2009.  The ratings agency expects the good times to continue, forecasting the U.S. high-yield default rate to decline to 2.6% by December.  
 
Consider the new lease on life given to companies that might face the economic grim reaper in a less forgiving interest rate world. According to Bianco Research, nearly 15% of components in the very broad S&P 1,500 index failed to generate sufficient average earnings before interest and taxes over a three year period to cover their interest expense at year-end 2017.  That compares to just over 12% in the fourth quarter of 2016 and less than 6% at the end of 2007.  Strip out energy, a particularly distressed realm in 2016 following the drop in West Texas Intermediate crude to below $30 a barrel from $100 in 2014, and 11.4% of the S&P 1,500 was so designated at year-end 2017. That’s exactly double the 5.7% rate of a decade prior. 
 
 
The March 23 edition of Grant’s (“The nine lives of the modern leveraged company”) took inventory of that extraordinary data point, observing both the broad implications for economic dynamism and, more narrowly, the risks which lurk as a greater share of companies struggle to pay the corporate bills as borrowing costs tick higher:
 
In a free market, unproductive firms give way to productive ones, much to the benefit of the consuming public. In this central bank-rigged, neurologically impaired market, unproductive firms don’t necessarily give way. They survive by borrowing at low interest rates. The great question is whether the unfit could survive even a moderate rise interest rates. 
 
That horde of corporate zombies may be tested sooner rather than later. Interest rate futures currently predict 48% odds of at least 50 basis points in additional rate hikes by year end.  The market assigns greater than 25% odds of at least 75 basis points in tightening by July 2019.  

Recap June 19

Stocks finished moderately lower, with outsized weakness in materials and industrials partially offset by a bid from interest-rate sensitive names. Treasury yields dropped, with the 10-year settling at 2.89%, while the Dollar Index rose above 95 for the first time since July.  That strength in the buck was none too well received by the commodity complex: The broad CRB index declined by more than 1% and is now off by more than 6% from its May 23 interim highs. 
 
- Philip Grant

Friday, May 22, 2020

Angel eyes
Misery loves company.

Recap May 22

Thursday, May 21, 2020

Yellow ledbetter

Wishing well
These coins must have fallen through the couch cracks.

QE progress report

Recap May 20

Wednesday, May 20, 2020

Risk management 2.0

Paper pushers

Northern exposure
Now they tell us.

Recap May 20

Tuesday, May 19, 2020

Pounded dough
The mouse is out of the house.

57 days later
The undead are dancing.

Recap May 19

Monday, May 18, 2020

Noises off

Depreciation day
Grading on a curve, writ-large.

Correction:

Recap May 18

Friday, May 15, 2020

Shelf life
Today, biotech company Sorrento Therapeutics, Inc.

King me
Debt monetization is here.

Recap May 15

Thursday, May 14, 2020

She said it

Rock center
It's good to be king.

QE progress report

Recap May 14

Tuesday, May 12, 2020

Some type of synergy

Liquid courage
A brave new world.

Recap May 12

Monday, May 11, 2020

Bed check

A ripple in the desert
This morning, the Kingdom of Saudi Arabia announced

Recap May 11

Friday, May 8, 2020

He said it

Break on through
A step closer to the other side.

Recap May 8

Thursday, May 7, 2020

Mr. Market's Wild Ride

QE progress report

Recap May 7

Wednesday, May 6, 2020

Learning by doing

Solar city
From the counter-cyclical chronicles:

Pressed juice
What's old is new again.

Recap May 6

Tuesday, May 5, 2020

Green thumb
A closer look at "whatever it takes."

Just add water
The Mortgage Bankers Association

Recap May 5

Monday, May 4, 2020

Model X
Call it Uber diets.

Recap May 4

Friday, May 1, 2020

Thanks for nothin'

Codependency credit
Torrents of red ink down Mexico way.

Recap May 1

Thursday, April 30, 2020

Credit check

Security master
This morning, the Federal Reserve announced it will expand the scope

QE progress report

Recap April 30

Tuesday, April 28, 2020

State of nature
Yesterday, New York governor Andrew Cuomo

Recap April 30

Monday, April 27, 2020

Liquidity check

Something shiny

Smoke 'em if ya got 'em
On April 17, Howard Willard, CEO of tobacco giant Altria Group

Recap April 27

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